$LCI Lannett Grows Revenue and Profits while Awaiting FDA Approvals

Lannett (AMEX:LCI) reported its second quarter fiscal year 2011 (Q2FY11) results for the three months ended 12/31/10 late this morning and will hold a conference call at 430pm (ET) today. Despite a backlog of pending FDA approvals for the Company's morphine sulfate oral solution New Drug Application (NDA) and other generic drug Abbreviated New Drug Applications (ANDAs), $LCI posted top and bottom line growth compared to the year-ago period.

During Q2FY11 (three months ending 12/31/10), $LCI reported net sales of $30 million (M) compared to $28.7M in the year-ago period and net income of $2.4M or $0.09 per share compared to break-even results in the year-ago period. Research & development expenses decreased to $1.7M (compared to $2.7M in the year-ago period) while selling, general and administrative (SG&A) expenses decreased to $2.9M vs. $4M in the year-ago period.

In DEC 2010, $LCI completed a secondary offering of its common stock for 3.25M shares @$5 for net proceeds of approximately $14.9M. As of year-end 2010, $LCI had $23.4M in cash / equivalents / investments with $3.1M in total debt, including $2.8M classified as long-term and $0.3M classified as current portion of long-term debt. $LCI has 28.3M shares of common stock outstanding for a market cap of approximately $158M based on a stock price of $5.60 per share during intraday trading.

The public offering of common stock in DEC 2010 included 2.5M shares sold by the Company (approx. 10% dilution), 2.5M shares sold by the chairman / founder (who still owns 5.7M shares as part of a group of 12 executives and directors that own over 12M shares), and 750,000 shares purchased by underwriters in the deal that exercised in full their over-allotment option.

CEO Arthur Bedrosian identified higher sales of oxycodone oral solution, levothyroxine, and OB Natal One tablets and lower operating expenses as key elements to the strong results for the quarter. While financial results continue to face a headwind (trailing six-month sales and profits are down from the year-ago period) from a backlog of FDA new product approvals, Mr. Bedrosian stated that several product applications (including the morphine sulfate oral solution NDA) are likely to be approved soon, pending a successful pre-approval manufacturing facility inspection by the FDA.

$LCI has been in business since 1942 and acquired Cody Labs in 2006, which is one of just seven US companies with a license to import opiate raw materials used in the production of narcotic / controlled substance pain relievers such as morphine and oxycodone -- providing a vertically integrated business model (from raw materials to market) within the niche pain management segment of the generic drug industry that is expected to lower manufacturing costs and expand profit margins.

Key products for $LCI include digoxin (87.9% market share) (Lanoxin, Digitek) (heart failure treatment) and levothyroxine (27.4% market share) (Synthroid, Levoxyl) (thyroid hormone replacement therapy), which have relatively few competitors within the generic drug industry as compared to other categories which may have more than 10 companies producing the same compound. It should also be noted that these two drugs are also subject to periodic shortages in the market, which I have experienced first-hand in my former life as a retail pharmacist. In addition, both of these drugs treat medical conditions in which it is crucial for patients to avoid missed doses.

Looking ahead, $LCI plans to expand its facilities (including those acquired with Cody Labs) and the Company currently has $2M in morphine inventory that can be used to re-launch the product quickly if FDA approval occurs as expected in early 2011 following successful facilities inspection. During Q1FY11 quarterly earnings three months ago, Mr. Bedrosian noted that sales and profits were adversely impacted by the loss of $2.8M in quarterly revenue from the FDA's action to force all but one competitor (ROXANOL) to cease distributing morphine sulfate oral solution.

In addition, the strong balance sheet and operating results provides the capital and confidence to expand the Company's pain drug business (Cody Labs facilities and staff), in addition to potential acquisitions of additional products or companies in the pain drug space or other areas.

Since the market for morphine sulfate oral solution now includes less competition and higher prices, sales for the product in 2011 (assuming 9 months of sales) could reach $9-10M, which does not account for additional upside potential to sales during 2011 based on additional product approvals pending successful FDA inspection. Assuming approval for 2-3 products during 1Q11 pending successful inspection, my estimate is for $130-135M in sales during calendar year 2011 for $LCI and net income of $12-12.5M or $0.42-0.44 per share. $LCI has an enterprise value (EV) of ($158M market cap + $3.1M debt less $23.4M cash / equivalents) of approximately $138M as of intraday trading at a stock price of $5.60 per share.

I plan to hold my long position in $LCI through expected approval of morphine sulfate oral solution and additional products, which may provide an upside catalyst for the stock price to a potential level of $7-8 (a valuation of approx. 1.5X EV / sales or 16-18X price / earnings or P / E ratio) as consistent growth is expected to occur in future sales and profits with the approvals - especially given the strong results reported in the last quarter that occurred despite the backlog in FDA product approvals.